Unresolved Issues, Unattractive Valuations Take Toll On Duke Energy

| About: Duke Energy (DUK)

Given my belief that the pending rate cases are likely to fuel future earnings growth for the company, I reiterate my 'hold' rating on Duke Energy (NYSE:DUK). However, any undesired outcome of these rate cases remains a near-term stock price risk. Also, DUK has a lower dividend yield of 4.4%, a higher PEG of 4.3 and modest growth projection of 3.6% as compared to its peers.

Financial Details
DUK reported adjusted earnings per share of $0.87 for 2Q2013, down 14% YoY, missing analyst estimates of $0.93. Reported net income for the recent second quarter came out to be $339 million, down from $444 million in the corresponding period last year. Earnings for the quarter were negatively affected as a result of lower PJM capacity prices, issuance of incremental shares and unfavorable foreign exchange rates.

The company's U.S. Franchised Electric and Gas segment posted healthy results in the recent second quarter; adjusted segment's income was up 75% YoY to $590 million in 2Q2013. Earnings for the segment were driven by merger-related savings and higher pricing. DUK's second biggest segment, the International Energy Segment, experienced a drop of 17% in its earnings in 2Q2013 due to lower volumes and currency movements. The Commercial Power Segment registered a loss of $3 million in 2Q2013 as compared to an adjusted income of $32 million in 2Q2012. The drop in the Commercial Power Segment's income was mainly due to lower PJM capacity revenues.

The company currently offers a safe dividend yield of 4.4%, which is backed by its strong operating cash flow yield of 12.5%. Also, the company has a strong dividend history, as it has not missed its regular quarterly dividend in the last 87 years, which is why I believe the dividends offered by the company are safe. DUK has a long term plan to increase its quarterly dividends, almost in line with its earnings growth, and is targeting its dividend payout ratio to be in a range of 65% -70%. The company's ability to increase dividends remains an important stock price catalyst. The table below shows the annual dividends paid by the company in recent years.

2009

2010

2011

2012

2013E

Annual Dividend/ Share

$2.88

$2.94

$3.00

$3.06

$3.12

Click to enlarge

Source: Company Reports

The outcome of the pending rate case remains another important stock price catalyst. The company has major rate cases pending in Duke South Carolina, Duke North Carolina and Ohio. The Ohio capacity decision is expected by 4Q2013. Any favorable outcomes on the pending rate cases would provide incremental earnings and cash flows in the near term. Last quarter, DUK acquired an approval for a 5.5% rate increase for the next two years from the North Carolina Utilities Commission.

The company has also been working to improve upon its cost structure, which should drive bottom line growth; DUK is targeting to reduce its non-fuel O&M expenses by 5%-7%.

Outlook
The company's management reiterated its 2013 full earnings per share guidance range of $4.20-$4.45. Analysts have forecast that DUK will earn $4.31 per share in the current year. The company's bottom-line results are likely to improve in 2H2013, as the pending rate cases and cost reduction efforts will fuel earnings growth. However, an unfavorable outcome of the pending rate cases and lesser-than-expected cost savings pose a risk to the company's earnings growth.

Conclusion
In the recent second quarter, the company's earnings were adversely affected mainly due to lower PJM capacity prices and unfavorable exchange rates. I believe that any unfavorable rate case outcomes pose a threat to the company's earnings growth potential. I recommend a hold rating for DUK, as the rate case outcomes can lead the stock price to be volatile in the short term.

Also, the company currently has unattractive valuations as compared to its peers. The company has a higher PEG of 4.3 as compared to its peers, which indicates that DUK offers relatively expensive growth. Moreover, the company has a lower dividend yield of 4.4% and a modest next five-year growth projection of 3.6% as compared to its peers.

DUK

Southern Company (NYSE:SO)

PPL Corp. (NYSE:PPL)

PEG

4.3

3.6

2.6

5 years Growth rate est.

3.6%

4.3%

5%

Dividend Yield

4.4%

4.6%

4.6%

Click to enlarge

Source: Yahoo Finance

I believe PPL Corp. offers a better investment opportunity than DUK. Click here to view my recent article on PPL Corp.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.